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In a new report from June 2018, Berlin Economics - an Independent Economy Policy Consulting agency - analyses multiple dimensions, in which a resolution of the Nagorno-Karabakh conflict is likely to lead to economic “benefits of peace” to Armenia and Azerbaijan: public finances, trade in goods and services, the energy and water sectors as well as financial markets and investments.

In this scenario, the report's authors assume a full resolution of the Nagorno-Karabakh conflict leading to a complete normalisation of relations between Armenia, Azerbaijan and Turkey with open borders, trade and the potential for cooperation.

The main economic benefits of peace for Armenia and Azerbaijan would lie in the three dimensions:

Public finances

The energy and water sectors

Financial markets and investments

In public finances, both Armenia and Azerbaijan would strongly benefit from large savings on conflict-related fiscal expenditures. Military expenditures could be reduced by 2% of annual GDP in both countries to a level comparable with other countries at peace. In addition, Armenia could save annual expenditures of 0.9% of GDP for supporting the local economy in Nagorno-Karabakh and 0.1% of GDP in interest payments, thus saving 3% of GDP every year. Azerbaijan could eventually save expenditures for supporting displaced people amounting to 0.4% of annual GDP, thus reducing total expenditure by 2.4% of GDP yearly. Such large fiscal savings would enable both countries to sharply reduce budget deficits and at the same time substantially increase spending in socially useful areas such as education or health by eliminating present budgetary pressures.

Very substantial “benefits of peace” could in the long run also be gained in the domain of the energy and water sectors. An integrated electricity market is a demanding political, technical and economic project, but would allow significantly cheaper generation of power. This would mainly benefit Armenia, deferring the need for investment into expensive new power plants as the country could import electricity during the dry season. The ability to purchase gas from Azerbaijan, which would require rehabilitation or reconstruction of pipelines, would also benefit Armenia, which would have a better bargaining position with competition on the supplier side, while Azerbaijan would gain a new customer and transit route. The joint management of shared water resources, however, would strongly benefit Azerbaijan, where water is scarce. A more efficient joint usage of water resources would lead to more and better quality water arriving in Azerbaijan from the Kura-Aras basin, its main freshwater source. Hence, very substantial gains exist, but as the benefits for both countries lie in different fields (energy for Armenia, water for Azerbaijan), these gains are not easy wins. In order to materialise the gains, trading benefits in the energy sector for benefits in the water sector (“energy for water deal”) could be a net gain for all involved parties.

Capital flows to Armenia and Azerbaijan are constrained at present to a large extent due to elevated country risk as a consequence of the ongoing conflict. The effect of country risk on ratings, risk premiums on bonds, loans and equity, investment and, finally, economic growth is likely to be very strong. Both countries’ ratings would probably improve by one notch (Armenia from B+/B1 to Baa3/BB-, Azerbaijan from BB+/Ba2 to BBB-/Ba1). This would lead to noticeable effects e.g. on sovereign Eurobond interest payments where fiscal savings for Armenia would amount to USD 10 m annually, USD 12.5 m for Azerbaijan. Most important, however is the long run effect on investment and economic growth. Increases in the inward FDI stocks due to reduced country risk could significantly and permanently elevate the level of GDP for both countries, by 3.4% to 6.0% of GDP in Armenia and 6.0%-10.6% in Azerbaijan.

In the dimension of trade, benefits of peace exist, but would overall be smaller than might be expected at first. As Armenia and Azerbaijan are both relatively small economies and complementarities in the export and import baskets are not large, bilateral goods trade would be limited at around 1% of total trade for Armenia and less than 1% of Azerbaijan’s total trade in the long run. Also, transport routes with other trade partners could not be shortened when borders are opened. Considerable benefits in trade would however materialise for Armenia due to an increase of trade with Turkey. Armenia would annually export USD 123 m to its western neighbour in the medium term, while in the long term the share of Turkey in Armenia’s trade would reach a sizeable 13%.

In summary, our research shows that a resolution of the Nagorno-Karabakh conflict would yield large economic benefits of peace and would hence be in the economic interest of both countries and their people. Both countries will benefit massively from increased investments. Armenia would in addition very strongly benefit from substantial fiscal savings, also due to reduced needs for expensive investments in power plants. For Azerbaijan, additional budgetary resources can be used to invest in people’s skills. The agricultural sector could grow thanks to better access to fresh water, supporting a gradual import substitution in the agro-food sector. In combination, this would contribute to reducing the country’s dependency on the oil and gas sector.

Considering the cumulative, multi-year impact of conflict resolution over a medium to long term perspective, it appears likely that 10 years after conflict resolution, both countries could be on a higher development path: on the one hand, huge annual fiscal savings will have permitted large public investment into the health and education of the populations as well as infrastructure, thus increasing productivity and wages. On the other hand, the reduction in country risk will have unlocked large volumes of investment, with a large impact on the permanent level of GDP. These effects will not only happen at the same time, but will reinforce each other to result in significantly improved standards of living in both countries. The economic benefits of peace hence form a strong argument in favour of finding a permanent solution to the Nagorno-Karabakh conflict.

Download the full report by clicking the link below, or learn more on Berlin Economics here.